Two Handed Economists

By Crest Capital Advisors on January 14, 2022

Dow: (0.88%) to 35,911.81
S&P 500: (0.30%) to 4,662.85
Nasdaq: (0.28%) to 14,893.75
Russell 2000: (0.80%) to 2,160.82
10 Year Yield: 1.78%
Outperformers: Energy 5.22%, Communication Services 0.52%
Underperformers: REITs (2.02%), Consumer Discretionary (1.47%), Utilities (1.40%)

US stocks were lower this week, with major indices adding to last week’s declines, but only marginally compared to some of the selling pressure underneath the surface. (More on this topic below) Stylistically, growth was a laggard to value, with the former seeing a big slump on Thursday. Energy led the market once again amid the strength in oil and elevated inflationary readings.
Stocks were lower on the week despite some early week thoughts the market dip was on the verge of turning back higher (e.g. buy the dip), considering last week’s rapid Treasury yield backup seems to have dissipated. (Yields were flat on the week) The S&P 500 rose on Tuesday and Wednesday as analysts and commentators debated whether the selloff was overdone and if it was time to “buy the dip”, especially given thoughts about the strong demand backdrop, solid equity market inflows, and expectations for another season of 20%+ earnings growth.
Overall it was a busy week for economic releases with the headline December CPI report up 7.0% year-over-year, the fastest pace since June 1982, and the 0.5% month-over-month increase faster than the 0.4% consensus. However, there was also a bit of deceleration in shelter prices and lower food costs that may provide relief in the months ahead. However, analysts did not see anything that was likely to alter the Fed’s policy path, and the market remains convinced interest rate ‘lift-off’ may begin as early as March with as many as (4) rate hikes over the course of 2022.
Looking to the week ahead, the Q4 earnings season officially takes center state and analysts are expecting to see a nearly 22% year-over-year increase from S&P 500 constituents (which would be the fourth straight 20%+ quarter) and revenue up nearly 13% year-over-year. Analyst commentary has been generally positive, with continued mentions of strong consumer demand and resilient profit margins. We look forward to seeing market emphasis shift back to earnings as economists give consideration to the other hand (e.g. “on the one hand we have higher inflation, but on the other, we have strong earnings”) and shift focus away from macro-inflationary fears, at least temporarily.

Sticker Shock

Another bad series of headline inflation reports were released this week, with consumer prices jumping by 7% in December from a year ago. This marks the eighth straight month of a figure higher than 5%, and the third consecutive month above 6%. It also represents the biggest annual increase since February of 1982! As a result, investors singular focus on “inflation, inflation, inflation” (And the resultant change in Fed behavior to address it) is driving a large rotation of capital, causing the US dollar (more on this below) to weaken, energy stocks to surge (best performers of 2022 thus far), and growth stocks to suffer severely (more on this below as well).
But what you’re not hearing in the media reports about inflation is…averages can be swayed by single (or several) large outlier(s)…medians cannot. The headline CPI of 7.0% represents the average increase across all price inputs. But the median CPI (defined as ½ of the inputs below this threshold and ½ above) was just 3.8%. Now there may be a good reason why the average is a better representation, perhaps we consume more of the stuff that is reflected in the average. (We do) But, it is telling that many of the inputs are actually not increasing at such a rapid rate, and really just 3 of the inputs explain much of the headline increase to 7%. In fact, if those factors were removed, the headline CPI would have been about 4.3%. Above the Fed’s target for sure, but much more manageable at those levels.
An additional consideration, if we were truly dealing with real monetary inflation, that would drive up the prices of everything. That is not what is happening today. It really is just a few conspicuous items that are throwing off the average, and creating a situation with one of the biggest differences between average and median in recent memory. Those (3) inputs are rent, motor fuels, and new/used cars. As we have suggested in recent weeks, if these items should moderate, even recede a bit in 2022, inflation will naturally come down on its own and return some monetary flexibility back to the Fed.

What are Passive ETFs Hiding?

Passive ETFs are hiding a bear market in stocks. That may sound like a strange statement when you look at major stock market indexes hovering within a short distance of all-time highs. However, much like an iceberg, what we see on the surface hides much of what lies beneath.

Currently, the top 10 stocks in the S&P 500 index comprise more than 1/3rd of the entire index. In other words, a 1% gain in the top 10 stocks is the same as a 1% gain in the bottom 90%. The same story holds for the Nasdaq, which is also heavily dominated by the same stocks as the S&P 500. As we noted in prior CMD’s, without the support of the top 10 holdings, recent calendar year returns and overall volatility would be very different.

And this is not just an S&P 500 or Nasdaq phenomenon, out of roughly 1750 ETF’s, the top-10 stocks of the S&P 500 index comprise approximately 25% of all issued ETFs. We suppose that makes sense as product issuers seek to sell good performance. Therefore, the continuous buying of ETFs keeps the largest capitalization, and hence the index themselves, elevated. Under the surface is a different story. As we progress into 2022, more than 38% of stocks trading on the Nasdaq are now down 50% from their 52-week highs. Only 13% of days since 1999 have seen more stocks cut in half. At no other point since at least 1999 have so many stocks been cut in half while the Nasdaq Composite index was so close to its peak. In the past, when at least 35% of stocks are down by half, the Composite has been down by an average of 47%. The last sentence is critical. There is no precedent for when so many stocks were in a bear market, yet the index was near its historical highs.

But for those feeling frustrated (count us in that camp), there are some conditions occurring today that indicate we may be close to the end of this selling pressure. And, as long-term investors, we know that technology stocks are where the big money is going to be made over the next 5 to 10 years. We know that this sell-off will pass. And we know that when it does, tech stocks are going to power higher once again. The opportunity is just too vast to overlook. Energy and bank stocks are darlings today, but they are not secular growers nor are they innovative sectors of the economy.
One technical analysis we ran yesterday hints that tech stocks are currently at or very close to a near-term bottom and that within the next few weeks, they’re likely going to rebound in a big way. Ever since the Covid-19 pandemic emerged in early 2020, the Invesco QQQ Trust (QQQ)…a proxy for the Nasdaq…has formed a habit of bottoming whenever it “double breaks” its 100-day moving average. That is, in each of the past four tech stock sell-offs over the past two years, the Invesco QQQ Trust broke its 100-day moving average once, rebounded, dropped, broke it again, and then bottomed.
This happened in October 2020. It happened in March 2021. It happened again in May 2021, and October 2021. And, it just happened again yesterday. That is, we got that big “second break” of the 100-day moving average in the QQQ yesterday.

Recent history says we’re either at or close to the bottom

Contrarian Corner

We’re back with our “contrarian corner” segment to call out some market sentiment anomalies that are beginning to look extreme again. Specifically, we noted this week that the percentage of bullish investors (as measured by the AAII US Investor Sentiment Gauge) has dropped considerably….to levels last seen in October (those with decent memories will recall this is the last time the market experience some wobble, only to reverse higher in November and December). This is noted by the green line in the chart below. The absolute level is just 24.90 and is basically at the lowest point over the last 12 months. And, as you would expect, the percentage of bearish investors (measured by the blue line) is steadily increasing with a reading of 38.30.
While these indicators are never accurate enough to call changes in trend to a specific day or week, we would note that levels today are typical of a market that may be prepared to change direction. Who’s ready to take the other side?

Emerging Markets?

Speaking of contrarian, who had emerging markets on their bingo card as the best-performing equity asset for 2022? Our guess is nobody did. We don’t know of any market strategists who were willing to stick their necks out on an emerging market call. Now, obviously, it’s early and a lot can and will change as we get deeper into the year. But the trend we referenced in the US Dollar (turning lower) is what’s catalyzing the movement to themes expected to perform well in a declining US dollar environment. This is why commodity and commodity equities, as well as foreign assets, are outperforming right now.

At the same time the US dollar trend is rolling over and heading lower (chart above), the emerging markets index is bouncing from support and signaling it may be poised to reverse the 2021 downtrend (Chart below).

Crazy Stat(s) of the Week

Here are this week’s crazy stats:

• US Private Equity deal value totaled $1.2 Trillion in 2021, as the blistering pace of dealmaking helped drive a boom across all sizes, sectors, and types. This $1.2 trillion figure is 64% higher than the previous record from 2019. And, at over 8,600, the deal count topped 2019’s record by 50%!

• In addition to ETF inflows, venture capital also saw record-breaking activity. Overall US venture capital funding topped $329 billion in 2021, nearly doubling the previous record.

Quote of the Week

“Today, economists test their ability to forecast the price of a used 2000 Honda Civic…There are other prices in the US economy, but if you want to understand US CPI, it helps to know what used car prices are doing.”                                 

– Paul Donovan, UBS Chief Economist (referencing this week’s CPI report)

Calendar of Events to Watch for the Week of January 17th

With the bellwether banks kicking off Q4 earnings season on Friday (Admittedly with a bit of a thud), earnings will remain front and center on the calendar for the next several weeks. The economic calendar will be fairly benign with the bulk of reports focused on real estate and overseas data. Markets will be closed on Monday in observance of the Martin Luther King holiday so the shortened week may be influenced early on by events happening in foreign markets.
Monday 1/17 – US Markets (and banks) are closed in observance of the Martin Luther King Jr. Holiday.
Tuesday 1/18 – The Empire State Index for January is expected to recede to 24.0 due largely to Omicron factors, down from 31.9 in December.
Wednesday 1/19 – US Housing Starts for December are expected to post a -1.7% decline after a blistering 11.8% in November. Housing Starts and Building Permits are both expected to slow as well as higher mortgage rates cool the housing market.
Thursday 1/20 – Looking overseas, we’ll get CPI data in Europe and Japan. Both regions are expected to follow the US and show elevated levels of consumer price inflation. Here at home, Existing Home Sales are expected to come in below the prior month.
Friday 1/21 – US Leading Indicators for December are anticipated to post a solid 0.8% month-over-month gain.

Source: FactSet